Yahoo Finance How Did AeroVironment Inc’s (NASDAQ:AVAV) 8.19% ROE Fare Against The Industry?
This article is intended for those of you who are at the beginning of your investing journey and want a simplistic look at the return on AeroVironment Inc (NASDAQ:AVAV) stock.
AeroVironment Inc (NASDAQ:AVAV) generated a below-average return on equity of 8.19% in the past 12 months, while its industry returned 13.69%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into AVAV’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of AVAV’s returns. Let me show you what I mean by this. View out our latest analysis for AeroVironment
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) weighs AeroVironment’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.082 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for AeroVironment, which is 9.08%. This means AeroVironment’s returns actually do not cover its own cost of equity, with a discrepancy of -0.89%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue AeroVironment can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. Since ROE can be inflated by excessive debt, we need to examine AeroVironment’s debt-to-equity level. Currently AeroVironment has virtually no debt, which means its returns are predominantly driven by equity capital. This could explain why AeroVironment’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. AeroVironment’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For AeroVironment, I’ve compiled three pertinent factors you should look at:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Valuation: What is AeroVironment worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether AeroVironment is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of AeroVironment? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
